Tesla board members must now rely on Elon Musk to pay legal expenses

Tesla will forego an important type of business insurance policy this year, the company revealed in a filing on Tuesday.

Under a new arrangement, board members at Tesla will be reliant on CEO Elon Musk to pay for their legal defense and settlements in many cases.

Tesla faces several shareholder lawsuits, including one that alleges the company misled investors when Musk tweeted he had secured funding to take Tesla private at $420 per share.

Nora Tam | South China Morning Post | Getty Images

Tesla said in a regulatory filing on Tuesday that rather than paying high premiums for it, the company would forego an important type of business insurance policy this year. The decision leaves current and future board members at Tesla reliant on CEO Elon Musk to pay for their legal defense and settlements in a range of high-stakes cases.

This type of policy-- "directors and officers liability insurance" (also known as D&O) -- protects a company, its board members and executive officers from having to pay for their own defense, settlements or judgments against them, when they face costly lawsuits.

Allianz Global senior underwriter Sunil Bangali, who declined to comment on Tesla specifically, added that D&O insurance can also function as a recruiting and retention tool for board talent, especially in the litigious business environment of the United States.

Here's how Tesla explained its decision in the filing:

"Tesla determined not to renew its directors and officers liability insurance policy for the 2019-2020 year due to disproportionately high premiums quoted by insurance companies. Instead, Elon Musk agreed with Tesla to personally provide coverage substantially equivalent to such a policy for a one-year period, and the other members of the Board are third-party beneficiaries thereof."

In the filing, Tesla also promised that the new arrangement would not impair "the independent judgment of the other members of the board" working alongside Musk. Musk is CEO and a board member of Tesla and was previously its chairman. He resigned from the chairman role in October 2018 to settle SEC charges.

A professor of corporate governance at the University of Delaware, Charles Elson, doubted Tesla's board members could be truly independent at this point.

"Having the CEO provide D&O personally for the directors is highly problematic because it is meant to protect them from decisions they make about him, among other things. Usually D&O gives them an ability to make decisions without fear of personal liability when they act appropriately," Elson said. "It's just a bad idea, in my view."

Tesla is in the midst of defending itself in shareholder and other lawsuits.

A federal judge decided earlier this month that Tesla and Musk will have to face a lawsuit over the CEO's infamous $420 tweets. Shareholders claim that Tesla misled them in 2018 when Musk said on Twitter that he was considering taking Tesla private for $420 per share, and had secured funding for the transaction. Shares skyrocketed, trading was halted and volatility followed.

In January, all board directors of Tesla besides Elon Musk settled a shareholder lawsuit over the company's $2.6 billion acquisition of SolarCity in 2016. They paid $60 million for their part of the settlement. But Musk is due to stand trial as a last defendant against claims he used Tesla to bail out a failing solar installer, which he co-founded and ran with his first cousins, Lyndon Rive and Peter Rive.

Tesla's history in court, no doubt, contributed to the company's ability to obtain D&O Insurance at an acceptable price.

While the decision to self-insure is unconventional, it's not unheard of, according to the managing member of Hirzel Law in Detroit, Kevin Hirzel.

He said that organizations that eschew D&O insurance, including several universities with large endowments, are confident they have enough cash on hand to pay their legal costs, settlements and any judgments rendered against them.

"If they think they will not get hit with big judgments, or have a lot of legal costs, large companies could hang on to some of their money instead of paying out insurance premiums this way," Hirzel said. "And they don't have to argue with their carrier over what is covered. But typically, any organization doing this would create a separate indemnification trust to keep a level of independence there."

Hirzel agreed with University of Delaware's Charles Elson.

"I'd be concerned if I were on the Tesla board. One part of the job is to monitor Elon Musk. It's difficult to do that if you have this financial tie to him," Hirzel said.